3 new metrics get added to the already 5 covered (some of which also see a
change in methodology) in the previous note and the 8 have been classified
into 3 categories with weights assigned to try and arrive at a better
picture on the banking sector. Dena Bank, United Bank & Allahabad Bank see
a big fall whereas City Union, IOB and Kotak Mahindra Bank see a quantum
jump in the ranks.




I believe the 3 new metrics are pertinent in the current scenario where
risk on asset quality & balance sheet could have a greater bearing then the
operational performance of the banking sector.

New metrics added
a. stressed sector exposure - funded                { i believe pertinent
in taking a view on the asset quality risk that may evolve in     b.
stressed sector exposure - non-funded        { the near future given the
uncertain times of slowing growth & high interest rates
c. quality of pension assumptions

Interestingly, as per our calculations SBI has about Rs.170bn towards
underfunded pension liab (Exhibit 13) and Andhra Bank, UCO Bank stand-out
for their exposure to the infrastructure sector (exhibit 7 & 12).

Category                        Weightage                Metrics
1. on-Balance Sheet risk        40%                        NPA volatility,
stressed asset classification, stressed sector exposure

2. off-Balance Sheet risk                40%                        Fee
income cost index, stressed sector exposure (non-funded), quality of
pension assumptions
3. P&L Discretion                20%                        Treasury income
volatility, discretionary provisioning

Some of the spectacular movements in rankings seen are:

Bank                        New ranking        Earlier ranking
Dena Bank                       4                33
United Bank of India       7                30
Allahabad Bank               8                26
Karur Vysya Bank         10                36
Axis Bank                       3                15
Canara Bank                   8                13
Idbi Bank                        1                 8
City Union Bank            25                3
Bank of Baroda               36                24
Bank of India                  31                17
IOB                                 20                5
Kotak Mahindra Bank      34                20
SBI                                  32                19

Some of the banks with a high exposure to our defined stressed sector are

Bank                        Funded exposure as % of networth
Non-fund based exposure as % of networth
Andhra Bank                35                                        130

UCO Bank                   32                                        80
Canara Bank                30                                        170
KVB                            28
United Bank                22                                        20
Axis Bank                   15                                        130

Yes Bank                                                              180

Banks that stake up well/poor based on overall forensic scores and
valuations.

Strong candidates        Bank of Baroda, Central Bank, Federal Bank and
City Union Bank
Weak candidates        Yes Bank and Axis Bank

Can I request for some of your time to briefly discuss our findings and
thoughts on the changing landscape of the banking sector.

We rank Indian banks based on their & off Balance Sheet risks and the
extent of P&L discretion that they are exercising. We find that amongst:
(a) The new private sector banks, Axis Bank and Yes Bank look exposed; (b)
The major public sector banks, Bank of Baroda stands out as being the least
risky; (c) The old private sector banks, Federal Bank appears to be running
a well-balanced operation.

The modus operandi
Our 11th July note highlighted the tendency of Indian banks (particularly
public sector banks) to use evergreening and restructuring to flatter their
reported NPAs. We also highlighted the extent to which Indian banks
(particularly the new private sector banks) take considerable amounts of
off-Balance Sheet risk to earn fee income which flatters their ROEs. The
note went on to highlight the use of Treasury Income as a "balancing
figure" on the P&L of banks and the note also discussed the inadequacies in
the pension assumptions of the banks.

Quantifying the risks being taken by Indian banks

In this note, using the standalone financials for the last five years, we
quantify the risks being taken by 37 listed Indian banks under three
different categories: On Balance Sheet risk, Off Balance Sheet risk and P&L
discretion.
     On Balance Sheet risk (40% weight): The new private sector banks are
     clear winners on this front with all 7 new private sector banks
     featuring in the top half of our analysis. While 7 of the 9 old
     private sector banks figure in cluster C (clusters C and D are the
     weakest in our ranking matrix), the state-owned banks fare the
     poorest on this metric with 11 (of 21) state-owned banks in cluster
     D, the weakest bucket.
     Off Balance Sheet risk (40% weight): The state-owned banks bring up
     the rear in this parameter as well with only 5 (of 21) in the top
     half. A majority of the new private sector banks also figure in the
     bottom half. Hence, the old private sector banks are clear winners on
     this metric with 7 (of 9) in the top half of our scores for this
     metric.
     P&L discretion (20% weight): This metric measures the extent to which
     banks use Treasury income and provisioning to control their reported
     earnings. This is the only parameter on which state-owned banks fare
     well compared to the private sector banks with a majority of the
     state-owned banks featuring in the top half. Two-thirds of the
     private sector banks (old as well as new) figure in the bottom half.

Investment implications (see pages 15-26 for details)
Whilst the overall forensic scores of the banks (see table on the right),
highlight the accounting weaknesses of the state-owned banks, the market
has already factored this in for the most part (although we emphasise that
BOB and Central Bank score well in our model and look undervalued). In
contrast, Yes Bank and Axis Bank, which are trading at 3.3x and 3.4x FY11
book value respectively at present, have low forensic scores and look
overvalued. Lastly, the better quality old private sector banks, Federal
Bank (at 1.4x FY11 book value) and City Union Bank (at 2.0x FY11 book
value), appears to be worth investigating as long term outperformers.

Consolidated ranks based on the three categories of risk metrics
(On-Balance Sheet risk, Off-Balance Sheet risk and P&L Discretion)
(Embedded image moved to file: pic24626.gif)
*: We assign 40% weight each to "On balance sheet risk" and "Off balance
sheet risk" and the residual 20% weight to "P&L discretion"

Source: Ambit Capital research

2 of 2 Photo(s)